Post on 29-Jan-2015
description
20/12/2013 Corporate Valuations – Techniques & Application
“In the business world, the rearview mirror is always clearer than the windshield”
Warren Buffett
Valuation (Part – A)What and Why 5
How 12
Valuation in Indian Regulatory Environment (Part – B)When and Who 23
Macro Valuation Issues in M&A (Part – C)Why Merger 58
Valuation for Merger 64
Case Study 70
Some Specific Tricky Issues (Part – D)Tricky Issues 74
20/12/2013 Corporate Valuations – Techniques & Application
Part – A Valuation
WHAT & WHY
Value & Valuation
Value is*
An Economic concept;
An Estimate of likely prices to be concluded by the buyer and seller of a good or service
that is available for purchase;
Not a fact.
Valuation is the process of determining the “Economic Worth” of an Asset or
Company under certain assumptions and limiting conditions and subject to the data
available on the valuation date.
* Source -International Valuation Standard Council
20/12/2013 Corporate Valuations – Techniques & Application
Key Facts
PRICE IS NOT THE SAME AS VALUE
TRANSACTION CONCLUDES AT NEGOTIATED PRICES
VALUATION IS HYBRID OF ART & SCIENCE
VALUE VARIES WITH PERSON, PURPOSE AND TIME
20/12/2013 Corporate Valuations – Techniques & Application
S Standard of Valuation
T Thesis of Valuation
E Economics of Valuation
M Methodologies of Valuation
20/12/2013 Corporate Valuations – Techniques & Application
FAIR MARKET VALUE
INTRINSIC VALUE FAIR VALUE
INVESTMENT VALUE
Standard of Valuation
Thesis of Valuation Economics of Valuation
Methodologies of Valuation
Standard of Value is the hypothetical conditions under which a business is valued.
While selecting the Standard of Value following points is to be taken care of
Subject matter of Valuation;
Purpose of Valuation;
Statute;
Case Laws;
Circumstances.
Types of Standard of Value:
20/12/2013 Corporate Valuations – Techniques & Application
Standard of Valuation
Thesis of Valuation Economics of Valuation
Methodologies of Valuation
Thesis of Value is Premise of value which relates to the assumptions upon which
the valuation is based.
Premise of Value
Going Concern – Value as an ongoing operating business enterprise.
Liquidation – Value when business is terminated . It could be ‘forced’ or ‘orderly’.
Value-in-use
Value-in-exchange
20/12/2013 Corporate Valuations – Techniques & Application
Growing Cos.
Turnover/Profits: Increasing still Low Proven Track Record: Limited Valuation Methodology: Substantially on Business Model Cost of Capital: Quite High
High Growth Cos.
Turnover/Profits : Good Proven Track Record: Available Valuation Methodology: Business Model with Asset
Base Cost of Capital: Reasonable
Mature Cos.
Turnover/Profits: Saturated Proven Track Record: Widely Available Method of Valuation: More from Existing Assets Cost of Capital: May be High
Declining Cos.
`
Turnover/Profits: Drops Proven Track Record: Substantial
Operating History Method of Valuation: Entirely
from Existing Assets Cost of Capital: N.A.
Turnover/Profits: Negligible Proven Track Record: None Valuation Methodology: Entirely on Business Model Cost of Capital: Very High
Start Up Cos.
Turn
over
/ P
rofit
s
Time
Valuation across business cycle follow the law of economics
Standard of Valuation
Thesis of Valuation Economics of Valuation
Methodologies of Valuation
20/12/2013 Corporate Valuations – Techniques & Application
HOW
Enterprise / Business Value
Net Debt#
Equity#
Fixed Assets#
Net Current Assets#
Intangibles#
Stakeholders Assets
# Based on Market Values
20/12/2013 Corporate Valuations – Techniques & Application
Standard of Valuation
Thesis of Valuation Economics of Valuation
Methodologies of Valuation
Valuation Approaches
Income Based Method
Asset Based Method
Market Based Method
Fundamental Method Relative Method
Other Method
20/12/2013 Corporate Valuations – Techniques & Application
While concluding Value, all the methodologies must be considered and then weights applied
as per the facts of the case. In other words, Value conclusion should be based on the
Professional Judgement and Simple Average should best be avoided while concluding
Value.
Need of several valuation methods?
Each has strengths and weaknesses
Different methods useful in different situations
Each gives a different “take” on the value of the company’s stock
Provides a range of valuations instead of point estimates
Helps in Sanity Check
Choice of Valuation Approaches
“Value in Valuation is a question,
and
Your choice of Method is the first step
towards answer”
Applicability of a particular approach depends upon:
On whose behalf? – one buyer vs another buyer, buyer vs seller;
For what purpose? – independent strategic acquisition, group company consolidation, cross
border transaction;
When? – distress situation, industry downturn, boom etc;
20/12/2013 Corporate Valuations – Techniques & Application
Choice of Valuation Approaches
• In General, Income Approach is preferred;The dominance of profits for valuation of share was emphasised in “McCathies case”
(Taxation, 69 CLR 1) where it was said that “the real value of shares in a company will depend more on
the profits which the company has been making and should be capable of making, having regard to
the nature of its business, than upon the amount which the shares would realise on liquidation”.
This was also re-iterated by the Indian Courts in Commissioner of Wealth Tax v. Mahadeo Jalan’s
case (S.C.) (86 ITR 621) and Additional Commissioner of Gift Tax v. Kusumben D. Mahadevia (S.C.)
(122 ITR 38).
• However, Asset Approach is preferred in case of Asset heavy companies
and on liquidation;
•Market Approach is preferred in case of listed entity and to evaluate the
value of unlisted company by comparing it with its listed peers;
20/12/2013 Corporate Valuations – Techniques & Application
• Mergers
• IPO
• RBI
• Income Tax
• ESOP
• Companies Act
• SEBI
• Stock Exchange
Purpose Regulatory Accounting
• Purchase Price Allocation
Dispute Resolution
• Company Law Board/ Courts
• Impairment / Diminution
• Arbitration
• Mediation
• Acquisitions / Investment
• Voluntary Assessment
Value Creation
• Equity Research
• Credit Rating
• Corporate Planning
Valuation depends upon
20/12/2013 Corporate Valuations – Techniques & Application
Sources of Information for Valuation
Sources of Information
Historical financial results – Income Statement, Balance
Sheets and Cash Flows
Data available in Public Domain – Stock Exchange /
MCA/SEBI/Independent Report
Data on comparable companies – SALES/EV-
EBITDA/ PAT/BV
Promoters and Management background
Data on projects planned/under implementation including future
projection
Discussion and Representation with/by the management of the
Company
Industry and Regulatory trends
20/12/2013 Corporate Valuations – Techniques & Application
CASH FLOW Investor assign value based on the cash flow they expect to receive in the future - Dividends / distributions - Sale of liquidation proceeds Value of a cash flow stream is a function of - Timing of cash Receipt - Risk associated with the cashflow
ASSETS
Operating Assets - Assets used in the operation of the business including working capital, Property, Plant & Equipment & Intangible assets - Valuing of operating assets is generally reflected in the cash flow generated by the businessNon - Operating Assets - Assets not used in the operations including excess cash balances, and assets held for investment purposes, such as vacant land & Securities - Investors generally do not give much value to such assets and Structure modification may be necessary
Key drivers of valuation
That’s why DCF is most
prominent valuation
method
Need for Restructuring20/12/2013 Corporate Valuations – Techniques &
Application
Rule of Thumb
A rule of thumb or benchmark indicator is used as a
reasonableness check against the values determined by the
use of other valuation approaches.
Industry Valuation Parameters
Hospital EV/Room
Engineering Mcap/Order Book
Mutual Fund Asset under management
OIL EV/ Barrel of equivalent
Print Media EV/Subscriber
Power EV/MW, EBITDA/Per Unit
Entertainment & Media EV/Per screen
Metals EBITDA/Ton, EV/Metric ton
Textiles EBITDA depend upon capacity utilization Percentage & per spindle value
Pharma Bulk Drugs New Drug Approvals , Patents
Airlines EV/Plane or EV/passenger
Shipping EV/Order Book, Mcap/Order Book
Cement EV/Per ton & EBITDA/Per ton
Banks Non performing Assets , Current Account & Saving Account per Branch
However, Exclusive use of Rule of Thumb is not recommended20/12/2013 Corporate Valuations – Techniques &
Application
20/12/2013 Corporate Valuations – Techniques & Application
Part – B Valuation in Indian Regulatory Environment
WHEN & WHO
Inbound Investment Inbound Investment DFCFDFCF
Gift of Unquoted Equity Shares (Min)
Gift of Unquoted Equity Shares (Min) NAVNAV
Outbound Investment Outbound Investment Valuer DiscretionValuer Discretion
Gift of Unquoted Shares other than Equity Shares
Gift of Unquoted Shares other than Equity Shares Price it would fetch if sold in open
marketPrice it would fetch if sold in open
market
Takeover Code/ Delisting - Infrequently Traded
Takeover Code/ Delisting - Infrequently Traded
Only Parameters Prescribed – Return on Net Worth, EPS, NAV vis-a vis
Industry Average
Only Parameters Prescribed – Return on Net Worth, EPS, NAV vis-a vis
Industry Average
Takeover Code/ Delisting - Frequently Traded
Takeover Code/ Delisting - Frequently Traded Based on Market PriceBased on Market Price
Reserve Bank of India
ESOP Tax ESOP Tax Valuer DiscretionValuer Discretion
ESOP AccountingESOP Accounting Option – Pricing ModelOption – Pricing Model
Income Tax
SEBI
CA / MBCA / MB
>5Mn$ - MB, otherwise CA/MB>5Mn$ - MB, otherwise CA/MB
--
MBMB
MBMB
--
CA/MBCA/MB
--
Stock Exchanges Preferential Allotment to promoters / their relatives for consideration other than cash
Preferential Allotment to promoters / their relatives for consideration other than cash Valuer Discretion Valuer Discretion
Companies Act, 1956 Sweat EquitySweat Equity
Valuer DiscretionValuer Discretion
CA / MBCA / MB
--
Transactions Prescribed Methodologies Mandate to be done by
SNAPSHOT OF REGULATORY VALUATIONS IN INDIA
Gift of Unquoted Equity Shares from Resident (Max)
Gift of Unquoted Equity Shares from Resident (Max)
DCF (Valuation Based on Assets, Business & Intangibles is also
acceptable)
DCF (Valuation Based on Assets, Business & Intangibles is also
acceptable)FCA / MBFCA / MB
Preferential Allotment to OthersPreferential Allotment to Others Based on 26 weeks / 2 weeks Market Price
Based on 26 weeks / 2 weeks Market Price --
Companies Act, 2013
any property, stock, shares, debentures, securities or goodwill
or any other assets or the net worth of the Company or its
liabilities
any property, stock, shares, debentures, securities or goodwill
or any other assets or the net worth of the Company or its
liabilities
To be prescribedTo be prescribed REGISTERED VALUERREGISTERED VALUER
Transfer PricingTransfer Pricing Arm Length PriceArm Length Price --
RBI Valuation Guidelines
FDI VALUATION
• Notification No. FEMA 20/2000-RB dated May 3, 2000, as amended from time to time deals
with Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside
India) Regulations, 2000.
•In terms of Schedule 1 of the Notification, an Indian company may issue equity
shares/compulsorily convertible preference shares and compulsorily convertible debentures
(equity instruments) to a person resident outside India under the FDI policy, subject to inter alia,
compliance with the pricing guidelines.
•The price/ conversion formula of convertible capital instruments should be determined upfront
at the time of issue of the instruments.
Particulars Valuation before April 21, 2010 Valuation after April 21, 2010
Guidelines in Force CCI Guidelines In case of FDI Transactions:Listed Company: Market Value as per SEBI Preferential Allotment Guidelines
Unlisted Company: DFCF
In case of ODI Transactions:No method has been prescribed
Methods Prescribed Net Assets Value (NAV)Profit Earning Capacity Value(PECV)Market Value (in case of Listed Company)
Discount 15% Discount has been prescribed on account of Lack of Marketability
No such Discount has been prescribed
Historical / Futuristic It is based on Historical Values It is based on Future Projections
Possibility of variation in Value Conclusion
As valuation is more Formulae based, final values came standardized
As valuation is more dependent on Assumptions and choice of factors like Growth Rate, Cost of Capital etc, value conclusion may vary significantly.
FEMA Guidelines to Valuation
Note: Valuation guidelines do not apply to SEBI registered venture capital
Discounted Free Cash Flow Method (DFCF)
Approaches to FDI Valuation
RBI has prescribed DFCF as the only valuation method in case of FDI (excluding for
initial subscription); but has not provided any guidance on its technical aspects.
Though DFCF is one of the most acceptable Valuation methods used by Business
valuers worldwide; however DFCF for all FDI transactions-excluding for initial
subscription (like minority stake/start up valuation etc) may not yield Fair Value in
line with the Commercial understanding. However Law being such, suitable Logical
adjustments may be necessary on a case to case basis.DFCF expresses the present value of the business as a function of its future cash earnings capacity. In this method, the appraiser estimates the cash flows of any business after all operating expenses, taxes, and necessary investments in working capital and capital expenditure is being met. Valuing equity using the free cash flow to stockholders requires estimating only free cash flow to equity holders, after debt holders have been paid off.
DFCF expresses the present value of the business as a function of its future cash earnings capacity. In this method, the appraiser estimates the cash flows of any business after all operating expenses, taxes, and necessary investments in working capital and capital expenditure is being met. Valuing equity using the free cash flow to stockholders requires estimating only free cash flow to equity holders, after debt holders have been paid off.
Forward Looking and focuses on cash generation
Recognizes Time value of Money
Allows operating strategy to be built into a model
Incorporates value of Tangible and Intangible assets
Only as accurate as assumptions and projections used
Works best in producing a range of likely values
It Represents the Control Value
Major Characteristics of DFCF Valuation
DFCF Valuation Process
Understand Business Model
Identify Business Cycle
Analyze Historical Financial Performance
Review Industry and Regulatory Trends
Understand Future Growth Plans (including Capex needs)
Segregate Business and Other Cash Generating Assets
Identify Surplus Assets (assets not utilized for Business say
Land/Investments)
Create Business Projections (Profitability statement and Balance Sheets)
Discount Business Projections to Present (Explicit Period and Perpetuity)
Add Value of Surplus Assets and Subtract Value of Contingent Liabilities
Free Cash Flows- Value Trend
Terminal Value is calculated for the Perpetuity period based on the Adjusted last year cash flows of the Projected period.
Free cash flows to firm (FCFF) is calculated as
EBITDAEBITDA
Taxes
Change in Non Cash Working capital
Capital Expenditure
Free Cash Flow to
Firm
Note that an alternate to above is following (FCFE) method in which the value of Equity is directly valued in lieu of the value of Firm. Under this approach, the Interest and Finance charges is also deducted to arrive at the Free Cash Flows. Adjustment is also made for Debt (Inflows and Outflows) over the definite period of Cash Flows and also in Perpetuity workings.
Theoretically, the value conclusion should remain same irrespective of the method followed (FCFF or FCFE), (Provided, assumptions are consistent).
FREE CASH FLOWS
Free Cash Flow calculation
DISCOUNT RATE – WEIGHTED AVERAGE COST OF CAPITAL
Where:D = Debt part of capital structureE = Equity part of capital structureKd = Cost of Debt (Post tax)Ke = Cost of Equity
(Kd x D) + (Ke x E)
(D + E)
In case of following FCFE, Discount Rate is Ke and Not WACC
WACC
Cost of Capital calculation
DISCOUNT RATE - COST OF EQUITY
Where:Rf = Risk free rate of return (Generally taken as 10-year Government Bond Yield)B = Beta Value (Sensitivity of the stock returns to market returns)Ke = Cost of EquityRm= Market Rate of Return (Generally taken as Long Term average return of Stock Market)SCRP = Small Company Risk PremiumCSRP= Company specific Risk premium
Mod. CAPM Modelke = Rf + B ( Rm-Rf) + SCRP + CSRP
The Cost of Equity (Ke) is computed by using Modified Capital Asset Pricing
Model (Mod. CAPM)
Cost of Equity calculation
PERPETUITY FORMULA
– Usually comprises a Large part of Total Value and is sensitive to small changes
– Capitalizes FCF after definite forecast period as a growing perpetuity;
– Estimate Terminal Value using Terminal Value Multiplier applied on last year cash flows
– Gordon Formula is often used to derive the Terminal CashFlows by applying the last year cash flows as a multiple of the growth rate and discounting factor
– Estimated Terminal Value is then discounted to present day at company’s cost of capital based on the discounting factor of last year projected cash flows
(1 + g)
(WACC – g)
IMPORTANT TIP- It is advised to do Sanity check by applying Relative Valuation Multiples to the Terminal Year Financials and also doing Scenario Analysis.
Terminal value calculation
An Insight of Valuation- www.CorporateValuations.in
SEBI / Stock Exchange Valuation Guidelines
Traded Turnover of Shares ≥ 10%
[In the Last Twelve Calendar Months preceding the Month of Public Announcement (P.A.)]
Takeover Regulations
APPLICABLE LAW:
SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 2011
FREQUENTLY TRADED SHARES
Method of Valuation1.Highest Negotiated Price Per Share under agreement attracting the obligation to make P.A.
2.The volume weighted avg. price paid or payable by acquirer or PAC during the 52 Weeks;
3.The Highest Price paid or payable by acquirer or PAC in last 26 Weeks;
4.Volume weighted average Market Price of Shares for a period of 60 trading days
HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE FOR P.A.
Traded Turnover of Shares < 10%
[In the Last Twelve Calendar Months preceding the Month of Public Announcement (P.A.)]
INFREQUENTLY TRADED SHARES
Method of Valuation1.Book value, 2.Comparable Trading Multiples;
Such other Parameters as are customary for valuation of shares of such companies
Preferential Issue (1 of 3)
APPLICABLE LAW:
SEBI (ICDR) Regulations, 2009
Method of Valuation1.The average of the weekly high and low of the closing prices of the related equity shares quoted on the
recognised stock exchange during 26 weeks preceding the relevant date, or
2.The average of the weekly high and low of the closing prices of the related equity shares
quoted on the recognised stock exchange during 26 weeks preceding the relevant date.
HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE
Equity shares of issuer have been listed on recognized stock exchange for a period of 26 weeks or more as on relevant date
Preferential Issue ( 2 of 3)
APPLICABLE LAW:
SEBI (ICDR) Regulations, 2009
Method of Valuation
1. The price at which equity shares were issued by the issuer in its IPO or value per share
arrived at in a scheme of arrangement under section 391 to 394 of the Companies Act, 1956,
pursuant to which the equity shares of the issuer were listed, as the case may be , or
2.The average of the weekly high and low of the closing prices of the related equity shares
quoted on the recognised stock exchange during the period shares have been listed
preceding the relevant date, or
3.The average of the weekly high and low of the closing prices of the related equity shares
quoted on the recognised stock exchange during 2 weeks preceding the relevant date.
HIGHEST PRICE AMONG ALL IS THE VALUE PER SHARE
Equity shares of issuer have been listed on recognized stock exchange for a period of less than 26 weeks as on relevant date
Preferential Issue ( 3 of 3)
APPLICABLE LAW:
SEBI (ICDR) Regulations, 2009
Method of Valuation
No Method for Valuation has been prescribed.
Where equity shares have been issued to promoters / their relatives for consideration other
than cash, the valuation of assets in consideration for which the equity shares are issued
shall be done by an independent valuer
Valuer
Chartered Accountant or a Merchant Banker
ESOP Accounting Valuation
APPLICABLE LAW:
SEBI (ESOS and ESPS) Guidelines, 1999
Method of Valuation
Black-Scholes Model
If a Company listed on recognised stock exchange in India and issued shares under an
ESOS / ESPS, the fair value of stock option shall be estimated using an option pricing model
(Black-Scholes or a binomial model) which shall be treated as employee compensation cost
for the Company.
Valuer
Not Prescribed
Income Tax Act-1961
Equity Shares Valuation
APPLICABLE LAW:
Income Tax Act – 1961 and Rule 11UA
Method of Valuation
Minimum Valuation- Net Asset Value
Maximum Valuation- DCF and other methods factoring Tangible and Intangibles
If Individual, HUF, Firm or *closely held Company receives Equity shares of a closely held
Company – Valuation norms shall apply.
Valuer
No specific Valuer prescribed for undertaking Minimum Value
FCA / Merchant Banker for determining Maximum Value
*If a Public Listed Company receives any shares or anyone receives shares of a Public listed Company, valuation norms are not applicable if transaction takes at market price.
Valuation of shares other than Equity Shares
APPLICABLE LAW:
Income Tax Act – 1961 and Rule 11UA
Method of Valuation
Price at which such shares will fetch in the open market.
If Individual, HUF, Firm or *closely held Company receives shares other than Equity shares
of a closely held Company – Valuation norms shall apply.
Valuer
Valuation report to be issued by Merchant Banker
ESOP Tax Valuation
APPLICABLE LAW:
Income Tax Act – 1961 and Notification no. 94/2009 dated 18.12.2009 issued by CBDT
Method of Valuation
No method has been prescribed
To determine the value of perquisite taxable in hands of employees
Valuer
SEBI registered category – I Merchant Banker
Transfer Pricing
APPLICABLE LAW:
Section – 92 to 92F of Income Tax Act – 1961 and Rule 10A to 10E of Income-tax Rules, 1962
Method of Valuation
Arm Length Price
Any International transaction between associated enterprises at ARM LENGTH PRICE
Valuer
Not Prescribed
Role of TPO critical. Recent cases deliberating on Valuation aspects
20/12/2013
Registered ValuerCompanies Act, 2013
Registered Valuers
Registered Valuers
Financial Valuer Technical Valuer
• A Chartered Accountant,
Company Secretary or Cost
Accountant in whole time
practice or retired member
of Indian Corporate law
Service or any other person
as prescribed.
• A Merchant Banker
registered with SEBI and
which has in employment
under it CA/CS/CWA for
carrying out (signing)
Valuation by such qualified
persons.
• Member of the Institute
of Engineers or Member
of the Institute of
Architects in whole time
practice.
• A person or firm or LLP or
Merchant Banker
possessing both
qualifications may act in
dual capacity.
Shall have 5 Years of Continuous Experience, Post Qualification
Shall have 5 Years of Continues Experience, Post Qualification
Stock, Shares, Debentures, Securities, Goodwill
Property
Persons eligible to apply for being Registered as Valuer
Registered Valuer to be appointed by Audit Committee or in its absence by the Board of Directors.20/12/2013
Registered Valuers Registered Valuers
(Financial Valuation)
Value
Responsibilities• Valuer to make impartial, true and fair
valuation• Not undertake valuation if directly or
indirectly interested • Exercise due diligence• Valuation to be done as per rules
Upon contravention• Fine – 25,000 to 100,000
With intention to defraud• Imprisonment upto 1 year and• Fine- 1,00,000 to 5,00,000
Additionally upon contravention, to refund remuneration received and also liable for damages.
20/12/2013 Corporate Valuations – Techniques & Application
Section wise Requirement of Registered ValuersSection 62(1)(c) – For Valuing further Issue of Shares
Section 192(2) – For Valuing Assets involved in Arrangement of Non Cash transactions involving Directors
Section 230(2)(c)(v) – For Valuing Shares, Property and Assets of the company under a Scheme of Corporate
Debt Restructuring
Section 230(3) and 232(2)(d) – For Valuation including Share swap ratio under a Scheme of
Compromise/Arrangement, a copy of Valuation Report by Expert, if any shall be accompanied
Section 232(3)(h) - Where under a Scheme of Compromise/Arrangement the transferor company is a listed
company and the transferee company is an unlisted company, for exit opportunity to the shareholders of
transferor company, valuation may be required to be made by the Tribunal
Section 236(2) – For Valuing Equity Shares held by Minority Shareholders
Section 260(2)(c) – For preparing Valuation report in respect of Shares and Assets to arrive at the Reserve Price or
Lease rent or Share Exchange Ratio for Company Administrator
Section 281(1)(a) – For Valuing Assets for submission of report by Company Liquidator
Section 305(2)(d) – For report on the Assets of the company for preparation of declaration of solvency under
voluntary winding up
Section 319(3)(b) – For Valuing the interest of any dissenting member of the transferor company who did not
vote in favour of the special resolution, as may be required by the Company Liquidator
Section 325(1)(b) – For valuation of annuities and future and contingent liabilities in winding up of
insolvent company
20/12/2013 Corporate Valuations – Techniques & Application
Registered Valuers (Draft Rules) – Methods of Valuation
I. Before adopting methods, decide Valuation Approach-
• Asset Approach
• Income Approach
• Market Approach
II. Valuer to consider following points while undertaking Valuation-
•Nature of the Business and the History of the Enterprise from its inception
•Economic outlook in general and outlook of the specific industry in particular
•Book Value of the stock and the Financial condition of the business
•Earning Capacity of the company
•Dividend-Paying Capacity of the company.
•Goodwill or other Intangible value
•Sales of the stock and the Size of the block of stock to be valued
•Market prices of stock of corporations engaged in the same or a similar line of business
•Contingent Liabilities or substantial legal issues, within India and Abroad, impacting business
•Nature of Instrument proposed to be issued, and nature of transaction contemplated by parties
20/12/2013 Corporate Valuations – Techniques & Application
Registered Valuers (Draft Rules) – Methods of Valuation
III. Registered Valuer shall make valuation of any asset in accordance with any one or more of the following methods-
a.Net Asset Value Method (NAV)
b.Market Price Method
c.Yield Method / PECV Method
d.Discounted Cash Flow Method (DCF)
e.Comparable Companies Multiples Method (CCM)
f.Comparable Transaction Multiples Method (CTM)
g.Price of Recent Investment Method (PORI)
h.Sum of the parts Valuation Method (SOTP)
i.Liquidation Value
j.Weighted Average Method
k.Any other method accepted or notified by RBI, SEBI or Income Tax Authorities
l.Any other method that valuer may deem fit provided adequate justification for use of suh method (and not
any of the above methods) is provided
IV. Registered Valuer shall make valuation of any asset as on the Valuation date and in accordance with applicable standards, if any stipulated for this purpose.
V. Contents of Valuation report shall contain information as contained in Form 17.3
Registered Valuers (Forms) – Contents of Valuation report
1) Description of valuation engagement
(a) Name of the client:
(b) Other intended users:
(c) Purpose for valuation:
(2) Description of business/ asset / liability being valued
(a) Nature of business or asset / liability
(b) Legal background
(c) Financial aspects
(d) Tax matters
(3) Description of the information underlying the valuation
(a) Analysis of past results
(b) Budgets, with underlying assumptions
(c) Availability and quality of underlying data
(d) Review of budgets for plausibility
(e) Statement of responsibility for information received
20/12/2013 Corporate Valuations – Techniques & Application
Registered Valuers (Forms) – Contents of Valuation report (4) Description of specific valuation of assets used in the business:
(a)Basis or bases of value
(b) Valuation Date
(c) Description of the procedures carried out
(d) Principles used in the valuation
(e) The valuation method used and reasoning
(f) Nature, scope and quality of underlying data and
(g) The extent of estimates and assumptions together with considerations underlying them
(5) Confirmation that the valuation has been undertaken in accordance with these Rules
(6) Further it is certified that valuation has been undertaken after taking into account relevant conditions/regulations/rules/notifications, if any, issued by the Central/State Government(s) from time to time.
(i)The valuation report must clearly state the significant assumptions upon which the value is based. When reporting there may be instances, where there are confidential figures, these must be summarized in a separate exhibit
(ii)In his valuation report, the registered valuer must set out a clear value or range of values along with the reasoning
(ii)In case the valuer has been involved in valuing any part of the subject matter of valuation in the past, the past valuation report(s) should be attached and referred to herein. In case a different basis has been adopted for valuation (than adopted in the past), the valuer should justify the reason for such differences
Part – C
Macro Issues of Valuation in MERGERS & ACQUISITION
Why Merger
Particulars Effect Market Cap
Surplus Assets [including Cash]
Excess Debt in Capital Structure
Excess Trading Business in Manufacturing Sector
Diversified Business Model
Excess Business in Subsidiary Company
Company Performance [Operating Profits; Net Profits; New Products;
Capacity Expansion]
Increasing Cash Flows of Business
Better Corporate Governance
Better Disclosures [Investor, Analysts & Stakeholders Communication]
Regular Dividends / Bonus / Buyback
Corporate Re-organisation / M&A
Joint Ventures / Acquisitions
Market Perception
Capital Market Valuation
20/12/2013 Corporate Valuations – Techniques & Application
M&A
Mergers Acquisitions
Stock Purchase
COURT PROCESS NON - COURT PROCESS
SEBI [TAKEOVER CODE](only if Listed Co. is involved)
Companies Act
Types and Modes of M &A
Asset Purchase
Slump Sale Itemized Sale
20/12/2013 Corporate Valuations – Techniques & Application
Key Drivers for Re-organization
Unlocking of Value and its Sustainability
Positioning the businesses to be more
competitive
Business clarity to Investors and Analysts
Improving Governance Processes
Making Businesswise Fund raising possible
Business Risk Management
Restatement of Balance Sheet
Investor Relations
Stock & Credit Re-rating
20/12/2013
Takeover Regulations
Competition Commission
of India
Companies Act, 2013
Income Tax (DTC)
Stamp Duty
Indirect Tax
(GST)
Regulatory aspects under various statues
SEBI and
Stock Exchanges
FEMA
20/12/2013 Corporate Valuations – Techniques & Application
M&A objectives – What it means?
Diversification of Risks
Access to New Technology and Knowledge
Gain access to new markets, customers, products
Ability to limit competition / gain market share
Synergies & Economies of Scale
M&A is primarily driven with motive of achieving Inorganic growth and Synergy i.e. the potential additional value gain from
combining two firms, either from operational or financial sources.
However, certain studies have shown that most – but not all – M&A fail to deliver value and bridge the price-value gap
One of the reasons is that the aggressive promoters in consultation with eager advisors may result in pushing up the acquisition
price; Resultantly, the value often get transferred from acquirer’s shareholders to target company’s shareholders;
20/12/2013 Corporate Valuations – Techniques & Application
Valuation for Merger
Valuation for Merger
Judicial Pronouncements;
WHETHER VALUATION IS REQUIRED FOR MERGER?
In the matter of Shreya’s India (P) Ltd. v. Samrat Industries (P) Ltd. the Regional Director (RD) raised an objection that no valuation report has been filed and that the exchange ratio for amalgamation has not been worked out by an independent valuer.
“The Hon’ble High Court of Rajasthan overruled this objection and sanctioned the scheme of amalgamation by holding that there was no legal or factual impediment to grant sanction to the scheme of amalgamation.”
WHETHER ANY VALUATION METHODOLDY IS REQUIRED FOR MERGER?Though there are no specific methodology prescribed for valuation under Merger, however In Hindustan Lever Employees Union v. Hindustan Lever Ltd and Others, Bombay High Court -
“accepted the ratio of 2:2:1 as Income, Market and Asset Approach on which the valuation was based.”
20/12/2013 Corporate Valuations – Techniques & Application
“Valuation is generally the Starting Point of the M&A process”
Tool for planning Stamp Duty ?
Valuation for Merger.. Contd..
APPLICABLE LAW FOR VALUATION FOR MERGER INVOLVING LISTED COMPANY:
1.Companies Act, 1956 [Section 391- 394];
2.Fairness Opinion [Clause 24 (h) of the Listing Agreement];
3.SEBI Notification [CIR/CFD/DIL/5/2013], dated 4th February, 2013 and 21st May 2013 Circular
VALUATION REQUIREMENT UNDER SEBI NOTIFICATION
After the SEBI notification, Valuation by Independent CA is required if
shares are issued under the merger and there is change in shareholding
pattern.
Valuation by independent chartered account mandatory other than those specifically exempted.
''Valuation Report from an Independent Chartered Accountant'' is not required in cases where
there is no change in the shareholding pattern of the listed company / resultant company.
1. Differences in Risk Assessment arising from - Company Specific Risk
• Management capability• Future Cash Flows
Industry Risk - Business Cycles, Industry Outlook
2. Intangible Asset Valuations
3. Unproductive, high value fixed assets housed in target company
4. Cash and Stock Payout ratio
5. Ability to raise funding on buyer’s or target company’s b/s
6. Estimation of synergies (cost and revenue)
Why is there a Mismatch between Buyer & Seller expectations?
20/12/2013 Corporate Valuations – Techniques & Application
Need for Restructuring
• In case of a merger valuation, the emphasis is on arriving at the relative values of
the shares of the merging companies to facilitate determination of the swap ratio
– Hence, the purpose is not to arrive at absolute values of the shares of the
companies
• The key issue to be addressed is that of fairness to all shareholders
– This is particularly important where the shareholding pattern and shareholders
vary between the two companies
• There are established legal precedence for merger valuation methodologies
– Valuer’s role is to incorporate case specific factors and use appropriate
methodologies so as to determine a fair ratio
– Usually, best to give weight ages to valuation by all methods
– Market price method and Earnings methods dominate.
Swap Ratio Valuation
20/12/2013 Corporate Valuations – Techniques & Application
• If the exchange ratio is set too high, there will be a transfer of wealth
from the bidding firm’s stockholders to the target firm’s stockholders.
• If the exchange ratio is set too low, there will be transfer of wealth from
the target firm to the bidding firm’s stockholders.
Impact of Swap Ratio Valuation
20/12/2013 Corporate Valuations – Techniques & Application
CASE STUDYCalculation of
Exchange Ratio in M&A and
Independent Buyer-Seller perspective
20/12/2013 Corporate Valuations – Techniques & Application
Features of Steel Company*o Frequently Traded Listed Companyo Low Profit Margin, due to high Power Costo Running in Low Capacity Utilization due to poor supply of Power
Features of Power Company*o Unlisted Companyo Company is implementing the Power Plant of 9.5 MW , The Production is expected to
start with in Year
Acquisition Rationaleo Location Advantage, both companies have their unit in same Locationo Synergistic benefits- (Captive Power Plant will reduce the Operating cost, because Steel
Industry is energy consuming)o Tax benefit from the unabsorbed losses of Power Company o Up the value chaino Capacity utilization will increase in existing steel business, due easy availability of Power
*Common Promoter Group
Merger of a Unlisted Power Company into Listed Steel Manufacturing Company
20/12/2013 Corporate Valuations – Techniques & Application
EXCHANGE RATIO & VALUATION –MERGER• Valuation on Steel Company
• Valuation on Power Company
Valuation Method Rs Crores Weights
Value of Company Weighted Value
Market Cap 2 100 200
Income Method 2 95 190
NAV 1 150 150
Fair Value of Company 108
Valuation Method Rs Crores
WeightsValue of
CompanyWeighted Value
Market Cap 2 NA NA
Income Method^ 2 90 180
NAV 1 50 50
Fair Value of Company 76.67^ considering 3 years forward earnings and 80-90% Capacity utilization basis
Merger of a Unlisted Power Company into Listed Steel Manufacturing Company
20/12/2013
Pre Merger Shareholding of Steel Company
Category No of shares % Holding
Promoter 5,000,000 50%
Public 5,000,000 50%
Total 10,000,000 100%
Pre Merger Shareholding of Power Company
Category No of shares % Holding
Promoter 5,000,000 100%
Public - -
Total 5,000,000 100%
Post Merger Shareholding of Steel Company
Category No of shares % Holding
Promoter 12,099,074 71%
Public 5,000,000 29%
Total 17,099,074 100%
Independent Buyer-Seller Perspective
Valuation of Power business on as is basis – Rs.55 crores Assets MethodEarnings Method (Includes premium for the license)
Valuation of Power business taking into account synergies – Rs. 70 crores
An independent Buyer would bid an amount in excess of valuation on standalone basis (Rs. 55 crores) and below Synergy valuation (Rs.70 crores).
Acquisition Price would finally depend on negotiations.
Pre and Post Shareholding
20/12/2013 Corporate Valuations – Techniques & Application
Part – D
Some Specific Tricky Issues
Pre Money or Post Money: If the effect of the money coming in Company is
taken in Projections, the Expanded capital base should be considered or else the
Equity Value should be reduced by the inflow amount to reconcile with the existing
capital base.
Terminal growth rate: Since it is tough to estimate the perpetual growth rate of a
company, it is preferred to take the perpetuity growth rate factoring in long term
estimated GDP of the Country and Historical/Projection Inflation of the Country.
Projection Validation via-a-vis Industry: Need to have Sanity check of the
projections with the trend of the industry.
Beta of Unlisted Company: It is calculated on relative basis by adjusting the
average beta of its comparable companies for differences in Capital Structure of the
unlisted company with the listed peers.
Risk Free Rate: Yield of a Zero Coupon Bond or Long Term government Bond yield
should be taken as the risk free rate since it does not have any reinvestment risk .
Tricky issues in DFCF
20/12/2013 Corporate Valuations – Techniques & Application
Adjustment of Company Specific Risk Premium or Small Company Risk
Premium: Small Companies are generally more risky than big companies. CAPM
model does not take into consideration the size risk and specific company risk as
Beta measures only systematic risk and Market Risk Premium (generally
pertaining to Sensex Companies). These risks should also be taken into account
while computing the cost of equity.
Length of Projections: The Projected Cash Flows should factor in the entire
Business Cycle of a Company.
Notional/Actual Tax: Actual Tax Liability may be worked out and replaced for the
Notional Tax Liability
Investments: Investments should be valued separately based on their
Independent Cash Flows
Surplus Assets: The Value of Surplus Assets (not being utilized for Business
purposes) should be added separately and their cash flows should be ignored
while computing the Free Cash Flows.
Tricky issues in DFCF (Cont.)
20/12/2013 Corporate Valuations – Techniques & Application
Discounts
• Discount for Entity Level
Discounts & Premiums come into picture when there exist difference between the
subject being valued and the Methodologies applied. As this can translate control value
to non-control and vise versa , so these should be judiciously applied.
– Impact on entity as a whole
Key Person DiscountDiscount for Contingent Liability
Discount for diversified companyDiscount for Holding Company
•Discount for Shareholders Level– Impact on specific ownership interestDiscount Lack of Control (DLOC)Discount Lack of Marketability (DLOM)
•Size of distribution or dividends
•Dispute
•Revenue / Earning – Growth / Stability
•Private Company
Tax Payout
•% stake & special rights
•Shareholders Agreement caveats
Global Studies over the years on diversified
companies and holding companies has shown
that companies trade at a discount in the range
of 20%. to 40% each.
DLOM: As per CCI Guidelines, 15%
discount has been prescribed; however
practically DLOM and DLOC depends
upon following factors:
20/12/2013
Premium
“Beauty lies in the eyes of the beholder; valuation in
those of the buyer”
• An investor seeking to acquire control of a company is
typically willing to pay more than the current market price
of the company. Control premium is an amount that a
buyer is usually willing to pay over the fair market value of
a publicly traded company to acquire controlling stake in a
company.
• Control can be direct (shareholding or Authority to appoint
Board) or indirect (veto power, casting vote etc)
• Research has shown that the control premium in India has
ranged from 20% to 37% in the past few years having
median of 30%.
FinancialYear
No. ofTransactions
MedianPremium
2006 25 37%
2007 29 20%
2008 38 26%
2009 44 29%
2010 22 31%
2011 42 32%
Total 228 30%
20/12/2013 Corporate Valuations – Techniques & Application
Excess Cash and Non Operating Assets
Excess cash is defined as ‘total cash (in balance
sheet) – operating cash (i.e. minimum required
cash) to sustain operations (working capital) and
manage contingencies
Key Issue: Estimation of Excess Cash ?
Non operating Assets are the Surplus assets which are not used in operations of the business and does not
reflect its value in the operating earnings of the company. Therefore the fair market value of such Assets should
be separately added to the value derived through valuation methodologies to arrive at the value of the company.
One of the solutions is to estimate average
cash/sales or total balance sheet size of the
company’s relevant Industry and then estimate if the
company being valued has cash in excess of the
industry’s average.
What is an asset is not yielding adequate returns ?
20/12/2013 Corporate Valuations – Techniques & Application
Cross Holding and Investments
Holdings in other firms can be categorized into:
Types of Cross Holding Meaning
Minority, Passive Investments If the securities or assets owned in another firm represent less
than 20% of the overall ownership of that firm
Minority, Active Investments If the securities or assets owned in another firm represent
between 20% and 50% of the overall ownership of that firm
Majority, Active Investments If the securities or assets owned in another firm represent more
than 50% of the overall ownership of that firm
Investment Value
Ways to value Cross Holding and Investments:
Dividend Yield Capitalization or DCF based on expected
dividends Separate Valuation (Preferred)
By way of Shareholders
Agreement even less %
holding may command
control value20/12/2013 Corporate Valuations – Techniques &
Application
Accounting Practices and Tax issues
Most of the information that is used in
valuation comes from financial statements.
which in turn are made on certain
Accounting practices considered
appropriate.
•Cash Accounting v/s Accrual Accounting
•Operating Lease v/s Financial Lease
•Capitalization of Expenses
•Notional Tax vs. Actual Tax
•Treatment of Intangible Assets
•Companies Paying MAT
•Treatment of Tax benefits and Losses
20/12/2013 Corporate Valuations – Techniques & Application
Intangible Valuation
Identification of Intangible Assets:
• Market Related : Trade Marks, Service Marks etc.
• Customer Related : Customer Lists, Order backlogs etc.
• Artistic Related : Plays, Books, Pictures, Music, Video etc.
• Contract Related : Licensing, Royalty, Lease agreements etc.
• Technology Related : Patented Technology, Databases,
computer software's etc.
20/12/2013 Corporate Valuations – Techniques & Application
Purchase Price Allocation
What is a Purchase Price Allocation?
-an acquiring entity must allocate the purchase price to the assets acquired and liabilities assumed based on estimated fair values at the date of acquisition;
-The excess of the cost of an acquired entity (including tangible and intangible assets) over the net of the amounts assigned to assets acquired and liabilities assumed is recorded as “Goodwill”;
Consideration paid for
acquisitionAllocated to
Tangible Assets
Intangible Assets
Goodwill
In Proportion
to Fair Value
Balancing Figure
Intangible Valuation Cont.
20/12/2013 Corporate Valuations – Techniques & Application
Private Company Valuation
Some Data Issues:
Valuation of Unlisted
Company..
• Industry Misclassification• Infrequent Collection• Mixing Data from Different Sources• Omission or Inclusion of Information• Poor Data Quality• Tiny Sample Size
Guidance Note:
The valuation of shares should be carried out on the gross profits earned by the Company, as held in
Rakhra Sports Private Limited and Ors. v. Khraithilal Rakhra and Ors. (1993) Vol. 74 CC 545
While carrying out the valuation of shares, the valuer must take into account the salaries and perquisites
paid to the directors and related party transactions.
20/12/2013 Corporate Valuations – Techniques & Application
Company Specific Factors
• Management, Promoter Group
It is the alignment of
Company’s value via-a-
vis to its external
environment
• Operating, Capital and Corporate Finance Strategies
• Competitive advantages and cost position
• Product / Service offering / differentiation / pricing power
•Scale & Diversification
•Customer / Supplier concentration
•Corporate Governance
•Future prospects / Growth potential
•Industry peer group
•Regulatory environment
20/12/2013 Corporate Valuations – Techniques & Application
Valuation Methodologies and Value Impact
Major Valuation Methodologies Ideal for Result
Net Asset Value
Net Asset Value (Book Value) Minority ValueEquity Value
Net Asset Value (Fair Value) Control Value
Comparable Companies Multiples (CCM) Method
Price to Earning , Book Value MultipleMinority Value
Equity Value
EBIT , EBITDA Multiple Enterprise Value
Comparable Transaction Multiples (CTM) Method
Price to Earning , Book Value MultipleControl Value
Equity Value
EBIT , EBITDA Multiple Enterprise Value
Discounted Cash Flow (DCF)
Equity Control Value Equity Value
Firm Enterprise Value
20/12/2013 Corporate Valuations – Techniques & Application
Reliance Group Market prices (In Rs)
Pre demerger Post demerger
Reliance Industries 702 698
Reliance Capital Ventures - 23
Reliance Communication Ventures - 292
Reliance Energy Ventures - 43
Reliance Natural Resource - 18
TOTAL 702 1074
Demerger resulted in increased shareholders value
20/12/2013 Corporate Valuations – Techniques & Application
“That is what learning is, you suddenly understand
something you have understood all your life, but in a new
way”
…………………………….. Doris Lessing
Chander Sawhney, Vice President
Corporate Professionals Capital Pvt. Ltd.
SEBI registered merchant banker
Email : chander@indiacp.com
Mobile: 9810557353; Direct: 40622252
www.corporateprofessionals.com;
D-28, South Extension, Part-I, New Delhi-110049